Commentary – on Q4 2017 results

Roku transitions to an ad-driven business

Roku had a very strong finish to 2017, with strong growth in active users and revenue from its platform business. The company seems well positioned to take advantage of the expansion of the online TV market, despite a tightening streaming media player market.

Q4 2017 sees strong growth in Roku’s key strategies

One of the key strategies for Roku is to grow the base of active accounts. On that basis, 2017 was a very successful year. Active accounts increase 44% year-over-year (YoY) to 19.5 million. The amount of streaming time also increased sharply, up 54% to 4.3 billion hours. However, on a per active subscriber basis, viewing was flat over the previous quarter, though up from one year ago. In Q4 2017, the average active user streamed 2 hours and 25 minutes per day. In Q3, average users streamed 3 minutes more and in Q4 2016 16 minutes less.

Player market tightens

In the earnings call and the investor letter, Roku was clear that it does not view player sales as a key engine of revenue growth for the company. The player is a tool to help the company expand its user base:

“Our primary focus in selling players is to increase active accounts; we are not focused on maximizing hardware revenue and hardware gross profit.”

In an ultra-competitive market like streaming media players (SMPs), there is little opportunity to charge a premium price. Apple is trying with Apple TV but not seeing much success. Roku lowered the price of its premium player, the Ultra, from $129.99 to $99 in the fourth quarter. That help to boost unit sales volume by 25%, according to Roku’s CFO Steve Louden, but led to a 7% decline in player revenue versus Q4 2016.

Even though rivals are selling their SMPs at close to cost, Roku continues to make 9.5% gross margin on its player business. Last year in the same quarter gross margins were 13.3%. Expect margins to continue to tighten this year.

Platform revenue surges driven by advertising

Platform revenue continues to grow strongly. It grew 129% YoY to $85.4 million in 2017. It accounted for 45% of total revenue, up from 25% in 2016. The company expects it to overtake platform revenue in 2018. 75% of platform revenue comes from advertising and 25% from platform licensing.

Though it does not provide much revenue, license sales are an essential part of Roku’s strategy. Most importantly, the company continues to win over smart TV manufacturers and help them sell TVs. Anthony Wood, Roku Founder and CEO, says that: “1-in-5 smart TV’s sold in the US in 2017 were Roku TVs.” He later commented that half of the new active accounts came from licensed sources.

2017 was the first year that smart TV sales exceeded streaming media player sales. Roku’s strong footprint in the smart TV and SMP markets positions it well to continue to drive the expansion of active users throughout 2018 and beyond.

The success of The Roku Channel is helping drive ad revenue growth. The free ad-support channel launched late last year and is already the third most popular ad-supported channel on Roku. Mr. Woods was clear about the importance of ad revenue to Roku’s future:

“We are increasingly tapping into the $70 billion that US advertisers spend on TV as the TV ad ecosystem moves online.”

Wall Street unhappy with Roku

Roku said it will not make a profit in 2018 and will continue to invest heavily in growing the business. It also gave a very cautious forecast for 2018 revenue performance. These statements did not please Wall Street, which loped 20% from the stock price in next-day trading. However, it is worth remembering that building a valuable entertainment business takes time. Sam Toles, Senior Vice President of Digital and New Platform at MGM online, reminded me of this fact when I spoke with him earlier this month:

“The original cable TV channels did not make money for many years. The average was seven years before they started to turn a profit. Many of those companies became multi-billion-dollar businesses.”

He went on to say that the same is true for online television businesses. The question is, will investors give Roku the time it needs to build its business?

Why it matters

Roku is transitioning from a streaming media player company to an entertainment business.

It is making customer growth top priority, which will allow it to grow advertising sales into the main revenue earner for the business.